Does investing in sectoral equity mutual funds make sense?

With sector funds, the timing of the investment and the health of the concerned sector is very crucial.

Sector funds are mutual fund schemes that invest in a specific industry or sector only. This might sound counter-intuitive since mutual funds are preferred for the diversification they offer. However, sector funds also make a lot of sense for some investors.

Various mutual fund advisors tell their clients to entirely stay away from sector funds. This is largely because sector funds are very risky and therefore not ideal for the novice investor. With sector funds, the timing for investments and the sector is very crucial. If done right, you can get very high returns. The idea behind sector funds is that they allow you to concentrate your investment in an industry that is poised to grow rapidly. It’s like taking a bet on a particular sector.

For example, certain economic conditions might cause the automobile sector to grow at a rate much higher than other industries. And while many mutual funds will have exposure to companies in the automobile sector, they will also have investments in companies of other industries. So the true benefit of the growth in the automobile sector will not reach you as there will be several other sector’s performances to average the returns.

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Alternately, you could invest in the stocks of companies from the automobile sector. But the disadvantage of this method is that you would have to be skilled and knowledgeable in the art of picking the right stocks - besides having the time to do the same. In that light, sector funds make a lot of sense.

Let’s look at a few sectors to understand better.

Pharma Sector: This has been one of the best performing sectors until recently. Till late 2015, pharma sector funds gave returns that were unmatched. In fact, if you had invested in a good pharma sector fund in 2012, you would have tripled your money by late 2015. Over the same period, a diversified equity mutual fund would have only doubled your money.

More recently, this sector has not been performing very well. If you think the future of the pharmaceutical industry is bright, you should explore sector funds from this category. Reliance Pharma Fund and SBI Pharma Fund are two of the good performing pharma sector funds.

Infrastructure Sector: Given the push by the government, infrastructure is another sector that has performed exceptionally in the past 5 years. Moreover, this performance looks like it will, continue given that Budget 2018 promises many projects. Though there have been some questions about the government’s spending power, this sector still holds promise.

Another promise this sector has is that this is the final year before the general elections - a year when the government looks to quickly finish many projects. L&T Infrastructure Fund and UTI Infrastructure Fund are two prominent funds from this sector.

IT Sector: Prominent companies that funds from this sector invest in are Infosys, TCS, Wipro, among several others. The IT sector was doing very well till around 2015. After 2015, the performance plateaued and over the last year, it plummeted.

Several factors such as management problems, automation, Trump’s viewpoint on outsourcing and the H1B visa, and more, affected this sector and caused it to underperform.

The performance is beginning to pick up again as stability returns to the sector. Many IT firms have reduced their exposure to US markets and have worked around other issues plaguing them. ICICI Prudential Technology Fund is a popular fund from this category.

Rural Sector: Funds from this sector invest in companies that directly benefit from rural India. This would include companies from the consumer goods industry, agriculture industry, and automobile industry among various others.

Given India’s massive rural population and rising disposable income, this sector has consistently been doing very well and is expected to continue doing so.

Sundaram Rural India Fund is the most sought after mutual fund in this sector.

There are several sectors that you could explore investing in besides the ones mentioned above. Some examples are banking and financial sector, natural resources sector, automobile and logistics sector, FMCG sector.

Keep in Mind

Many thumb rules are followed when investing in mutual funds. These rules are often ignored when exploring sector funds.

With sector funds, you are betting on a sector. A given sector’s performance will vary with time. Certain industries go through rapid growth and then decline. Some keep on growing and some never grow significantly. The catch here is that since you are investing in a specific sector, you will be exposed to the ups and downs of the industry.

This works as long as the market does well in the long run, which has been the case for more than the past decade. But, this rule too may not apply to all sector funds. In case of sector funds, the returns can go down even when the markets are doing well. It completely depends on the health of that sector and the timing.

A good way to invest in a sector fund is to study the sector carefully and invest a lump sum when the future prospects of that sector fund look bright. You may continue to buy more, if the sector that you strongly believe in performs badly in short term.

Tips to keep in mind when investing in sector funds

Choose a sector you believe in: Always choose a sector you understand

When the markets are doing well, usually, most equity mutual funds perform positively. This makes investing in them easier. Such is not the case with sector funds. Even when the markets are not performing well overall, some sector funds may perform well. And vice versa.

Prepare for the risk:When investing in a sector fund, be prepared to handle the risk. Many times a given sector can get easily affected by external factors. In such cases, you are left with no option but to take the hit. At the same time, something equally positive can also happen.

So it wouldn’t be wise to put money you are dependent on in a sector fund. However, if it is money that does not impact you too much, you can take the bet.

Stay updated: It is necessary to remain alert and stay abreast of news from the sector you have invested in. Changes in policy, market conditions, consumer behavior, unforeseen incidents, and several other factors can easily influence a given industry.Sector funds can be great investments contrary to the belief of many. For investors who have good knowledge of a certain industry and would like to place a bet on it, sector funds can be a good proposition.